FRMO - FRMO Corp.

[Jurgis]

Does the investment thesis in FRMO depend on stahl's view about indexation ? is that not equivalent to buffett's view on several topics which does not drive value at BRK

 

It might not depend directly. However, this may affect returns:

If he's convinced that indexing is out to get him, he may not invest in companies that are possibly cheap/attractive, but index correlated.

He may not admit that some of HK products are subpar and either close them or look for better ones.

 

I will say that FRMO investment is hard to justify on fundamental basis. It is pretty much a jockey investment (or as Stahl fans would say, investment into optionality ;)). So for some people his comments on indexing is just noise and they will believe in him and FRMO anyway. For others, FRMO is valuation-expensive and they will ignore his comments as not related to their investment decision. There is some subset of investors that may become less interested in FRMO/Stahl based on his views and HK fund performance. Ultimately you have to decide which group you belong to. ;)

[rohitc99]

Does the investment thesis in FRMO depend on stahl's view about indexation ? is that not equivalent to buffett's view on several topics which does not drive value at BRK

 

It might not depend directly. However, this may affect returns:

If he's convinced that indexing is out to get him, he may not invest in companies that are possibly cheap/attractive, but index correlated.

He may not admit that some of HK products are subpar and either close them or look for better ones.

 

I will say that FRMO investment is hard to justify on fundamental basis. It is pretty much a jockey investment (or as Stahl fans would say, investment into optionality ;)). So for some people his comments on indexing is just noise and they will believe in him and FRMO anyway. For others, FRMO is valuation-expensive and they will ignore his comments as not related to their investment decision. There is some subset of investors that may become less interested in FRMO/Stahl based on his views and HK fund performance. Ultimately you have to decide which group you belong to. ;)

 

fair points. However the value of FRMO depends on how well HK performs (+ all the other investments in the exchanges). HK performance should be driven by the AUM/ fees which could depend on whether the various funds out perform the indexes (though that does not seem to be the case with a lot asset managers as long as they have story to sell). Also if they can sell the 'story' on owner operation indexes ..all the better.

 

So as long as enough 'paying customers' are convinced and pay up, HK and FRMO should do well :) considering what a lot of other hedge /mutual funds are able to deliver..that may not be too tough

[Jurgis]

That said, my guess is that index investing works only fewer than the majority of investors practice it and when it is equal-weighted or value-weighted. Imagine what happens as tons of money gets poured into valuation-agnostic indexes -- it pushes up the prices of companies that are already expensive while possibly pushing down the prices of companies that are cheaper. (Assuming people are abandoning value strategies for the valuation-agnostic market-weighted indexes.)

 

One can only use index as substitute for market if it is market-cap weighted.

I agree though that term "indexing" is beyond abused with all the "index of some weird definition and subset of market" ETFs recently.

 

You are right that market-cap weighted indexes won't work if very high percentage of people use them.

 

Unfortunately, equal-weighted or value-weighted indexes won't work for lower percentage of total participants than market-cap weighted. Let's take equal-weighted. Take a smallest market cap company in your index, let's call it Z. It is likely 100 to 1000 times smaller than the largest one in your index (call it A). Then there will be a point where your index will have to have more than 100% of Z shares. By definition, this will be a point where index has only 1/100 or 1/1000 of the company A. So the index size overall will be likely << than 50% of market. If you limit the index to having not more than 50% of Z, then it's even lower. Once you go over 100% of Z, you'd have to market weight at least the smallest part of the index...

[Jurgis]

fair points. However the value of FRMO depends on how well HK performs (+ all the other investments in the exchanges). HK performance should be driven by the AUM/ fees which could depend on whether the various funds out perform the indexes (though that does not seem to be the case with a lot asset managers as long as they have story to sell). Also if they can sell the 'story' on owner operation indexes ..all the better.

 

So as long as enough 'paying customers' are convinced and pay up, HK and FRMO should do well :) considering what a lot of other hedge /mutual funds are able to deliver..that may not be too tough

 

In that case you should be concerned about this quote:

In any case the lesson that we ultimately learned is that in the realm of asset management, smaller is better.

 

;)

[Gamecock-YT]

One would think given how much they decry index investing, why not invest in the owner operating companies they are touting? They might know a good vehicle to investing in.  8)

[vinod1]

I feel like the definitions for indexing are so vague that we might not have a productive conversation here.

 

For instance, while indexing is likely better than active investing, it's possible that market-weighted index could be worse -- it depends on whether the transaction costs of active investing are higher or lower than the costs of overweighting expensive holdings to cheap holdings.

 

That said, my guess is that index investing works only when fewer than the majority of investors practice it and when it is equal-weighted or value-weighted. Imagine what happens as tons of money gets poured into valuation-agnostic indexes -- it pushes up the prices of companies that are already expensive while possibly pushing down the prices of companies that are cheaper. (Assuming people are abandoning value strategies for the valuation-agnostic market-weighted indexes.)

 

Take a simple example.

 

Assume there are only 3 companies in the stock market with total market cap of $100 billion.

 

1. Company A with market cap of $90 billion

2. Company B with market cap of $9 billion

3. Company C with market cap of $1 billion

 

Assume 90% of investment dollars are indexed (market cap weighted). So indexers would hold 90% of each company $81 billion of company A, $8.1 billion in company B and $0.9 billion in company C.

 

Active investors in aggregate must hold the other 10% of the total stock market, $9 billion in company A, $$0.9 billion in company B and $0.1 billion in company C.

 

Since active investors would be paying 1% or more in fees and other costs. They would in aggregate with 100% certanity underperform the indexers.

 

Company A could be a vastly overvalued but active investors in aggregate are still guaranteed to under perform.

 

Vinod

[Picasso]

This indexation thing is a common talking point among underperforming funds.  I sort of lose respect for investors who use indexation as an excuse or potential risk.  It doesn't make any sense at all.  Wouldn't that argue that indexation would cause them to beat the market handedly by all the inefficiencies created in non-indexed securities?  But of course that hasn't been the case and I think a five year period is a long enough time to judge that.

 

I saw this is a recent letter by Zeke Ashton which I have attached.  I will take a quote from it but theres a long passage about indexation risks.

 

In last year’s letter, we described the mechanism of the feedback loop (both positive and negative) and its influence over human and market behavior. If what we have described above sounds like a great recipe to create a bubble (whether for a broadly owned group of securities such as the S&P500 or for a small slice of the investing universe such as 3D printing stocks) then you are getting the idea. The problem is that feedback loops go in both directions, and when a positive feedback loop turns into a negative feedback loop, what should be a modest sell-off or correction can turn into a crash. The risk is that when the time comes, there won’t be enough active managers buying into any big sell-off to absorb the shares being sold by index investors whose primary attraction to the index was that it was going up.

We’ve seen this dynamic play out before. Those readers who remember the late 1990’s tech bubble will recall the popularity of the NASDAQ 100 Index Fund, which was often referred to as the “Qs” because of its ticker, QQQ. Though index investors certainly weren’t the only ones that drank the Kool-Aid back in the day (many active managers did the same), when the Qs suddenly became unpopular, the index fell by roughly 80% over the course of three years. More recently, something similar happened with junior mining stocks and exchange traded index funds. To take one example, the Market Vectors Junior Gold Miners index ETF was created in late 2009 to satisfy an emerging demand for the category, and thanks to strong inflows the ETF climbed from an opening value of 100 to a high of 172 by December 2010. When gold investing fell out of favor, the ETF lost 85% of its value over the next four years. It is hard to know how much of the buying and the selling by investors via the index funds and ETFs contributed to this extreme volatility, but it seems likely that index vehicles played some role in facilitating both the exaggerated rise and the staggering fall as the popularity meter went from hot to cold.

CVF_Q4_2014.pdf

[vinod1]

Does the investment thesis in FRMO depend on stahl's view about indexation ? is that not equivalent to buffett's view on several topics which does not drive value at BRK

 

It might not depend directly. However, this may affect returns:

If he's convinced that indexing is out to get him, he may not invest in companies that are possibly cheap/attractive, but index correlated.

He may not admit that some of HK products are subpar and either close them or look for better ones.

 

I will say that FRMO investment is hard to justify on fundamental basis. It is pretty much a jockey investment (or as Stahl fans would say, investment into optionality ;)). So for some people his comments on indexing is just noise and they will believe in him and FRMO anyway. For others, FRMO is valuation-expensive and they will ignore his comments as not related to their investment decision. There is some subset of investors that may become less interested in FRMO/Stahl based on his views and HK fund performance. Ultimately you have to decide which group you belong to. ;)

 

fair points. However the value of FRMO depends on how well HK performs (+ all the other investments in the exchanges). HK performance should be driven by the AUM/ fees which could depend on whether the various funds out perform the indexes (though that does not seem to be the case with a lot asset managers as long as they have story to sell). Also if they can sell the 'story' on owner operation indexes ..all the better.

 

So as long as enough 'paying customers' are convinced and pay up, HK and FRMO should do well :) considering what a lot of other hedge /mutual funds are able to deliver..that may not be too tough

 

Indexing is something I think every investor and asset managers in particular should have a good understanding of. Indexing is very tough to beat, so does it not make sense to study your competitor in depth?

 

Take Oaktree for example, Howard Marks approach makes perfect sense. They have a healthy respect for market and I think they are likely to do very well for their clients over the long term. So I it is something I would invest in at the right price - a modest discount to a fair price.

 

On FRMO, I am trying to determine what their edge is. From his writings, I am not getting much confidence that they would perform well for their clients over the long term. So I am much more cautious about investing in them, unless they are dirt cheap.

 

Vinod

[louisdog]

Anybody happen to attend the annual meeting last week and would like to share any thoughts?

 

Thanks!

[Dustin T]

http://www.frmocorp.com/_content/letters/2015_FRMO_Transcript.pdf

 

latest transcript from shareholder meeting

[Fowci]

http://www.frmocorp.com/_content/letters/2015_FRMO_Transcript.pdf

 

latest transcript from shareholder meeting

 

Haha, questioner 12 sound familiar?

 

"Questioner12: I don’t know what the cash position of Berkshire Hathaway is, but I’m assuming it’s not 50%. If it were, it’s my guess that there are probably very few people in this room who

would have invested with Berkshire Hathaway, even though they have the highest respect for Warren Buffett. But they’re anxious to invest in FRMO because of you. There is a general sense

that you’re brilliant, and Steve ever so slightly less brilliant.

 

Murray Stahl: That’s not true!

 

Questioner 12: Oh, it is true. And with every day that one looks at the stock price, and every quarterly call, and certainly the annual meeting, there is the hope that Murray Stahl and Steven Bregman will have come up with some brilliant way to invest the money. There is a general belief that you’re crazy like a fox, and that the day is going to come when we’re going to wake up and, all of a sudden, there it is: the reason that you’ve accumulated cash. And it’s to do something not just average, but something extraordinary. I’m going to guess that everyone in this room has that same belief, that same hope, and, even more importantly, that same faith in you. The question is: is there something deep in your mind that you’re really looking for and that you’re really waiting for, and that we can get really excited about during this wait? "

 

Annoyingly Stahl made another silly comment analogising indexing to subprime mortages (in his opening remarks, nothing to do with the question above):

 

"We are in the research business, and we believe you should do serious research before you undertake an investment. Think about the last time we had a mortgage business—this was 2006-

2007—when there was no income verification on loans. How did that work out? I think less than satisfactorily. Now people are buying baskets of securities without research, which is the

equivalent, in a mortgage, of buying properties without income verification. We just don’t want to participate in practices like that. "

 

[Jurgis]

Pretty nice transcript. If FRMO was trading way lower, it could perhaps be a good cash substitute - like someone said about BRK.

 

I think people ask questions about cash and the stock is going nowhere (down) because there is a gap between stock valuation and FRMO holding a lot of cash.

[KinAlberta]

Trading lower - as in now?  :-)

[Jurgis]

Still >2x book. But now might be time to start thinking how much the book is understated.

 

I haven't bought more, but I might add.

[Guest notorious546]

Still >2x book. But now might be time to start thinking how much the book is understated.

 

I haven't bought more, but I might add.

 

by how much do you think book value is understated?

seems like we have been approaching the 2.0x book value number recently.

[Jurgis]

Looking at 2016 Q1 report, there are 91.7M current assets at fair value. These should be valued at 1x or lower if you think that cash is opportunity cost. Also this assumes that the investments did not drop in value since August, which is not guaranteed.

 

Then we have:

 

Investment in OneChicago, LLC, at cost 246,000

Investment in The Bermuda Stock Exchange, at cost 2,648,733

Investment in Horizon Kinetics LLC, at cost 11,365,679

Participation in Horizon Kinetics LLC Revenue Stream 10,200,000

 

I have to dig and think on how much these should be valued.

Just off the hip, they'd need to have current value >4*cost for market cap to correspond to "updated book".

Another observation: Horizon Kinetics still is the driver of this part, since Bermuda and OneChicago are so small. Bermuda has to go up 10x just to match Horizon in size.

 

So... need to dig more, but overall, it's still not cheap. But cheaper than it had been recently. :)

 

[WideMoat]

I am baffled that everyone values their investments at cost.  And conveniently without offering a rationale for that choice.

 

To wit, what is a fair multiple for a royalty stream on a financial asset manager?  Certainly it has to be higher than the average multiple on operating earnings of asset managers in general.  Folks around here seem to think that Franklin's after-tax PE of 11 is too cheap.  Wisdom Tree has a 32 PE; Virtus 23; Diamond Hill 16.  And those are the multiples after paying for SGA, marketing, interest, and taxes.

 

At any rate, a 20 multiple on a royalty stream of an asset manager doesn't strike me as expensive.  Certainly not with bond rates and equity prices where they are today.

 

Looking at 2016 Q1 report, there are 91.7M current assets at fair value. These should be valued at 1x or lower if you think that cash is opportunity cost. Also this assumes that the investments did not drop in value since August, which is not guaranteed.

 

Then we have:

 

Investment in OneChicago, LLC, at cost 246,000

Investment in The Bermuda Stock Exchange, at cost 2,648,733

Investment in Horizon Kinetics LLC, at cost 11,365,679

Participation in Horizon Kinetics LLC Revenue Stream 10,200,000

 

I have to dig and think on how much these should be valued.

Just off the hip, they'd need to have current value >4*cost for market cap to correspond to "updated book".

Another observation: Horizon Kinetics still is the driver of this part, since Bermuda and OneChicago are so small. Bermuda has to go up 10x just to match Horizon in size.

 

So... need to dig more, but overall, it's still not cheap. But cheaper than it had been recently. :)

[Jurgis]

I am baffled that everyone values their investments at cost.  And conveniently without offering a rationale for that choice.

 

Who values their investments at cost?

Let's not throw baseless accusations here.

 

To wit, what is a fair multiple for a royalty stream on a financial asset manager?  Certainly it has to be higher than the average multiple on operating earnings of asset managers in general.  Folks around here seem to think that Franklin's after-tax PE of 11 is too cheap.  Wisdom Tree has a 32 PE; Virtus 23; Diamond Hill 16.  And those are the multiples after paying for SGA, marketing, interest, and taxes.

 

At any rate, a 20 multiple on a royalty stream of an asset manager doesn't strike me as expensive.  Certainly not with bond rates and equity prices where they are today.

 

Are you sure you're not comparing apples to oranges?

 

OK, let's say it's 20 multiple. Can you tell me 20 multiple on what? I would guess it's on the ongoing earnings from HK, not on their cost of HK investment. So then what is their ongoing earnings from HK? This is actually not split out in their reports. If it's "consultancy and advisory fees", that's around 700Kx4 = 2.8M annualized. So you are saying their HK share should be valued at 2.8M x 20 = 56M? OK. Even with that 56M + 91.7M for current assets + 10M for Bermuda/OneChicago (generous, no?) == 158M. Way lower than market cap.

 

Or are you saying that it's "income from investment partnerships and limited liability companies"? IIUC, that's not HK or at least not just HK. That's 800k x 4 = 3.2M annualized. OK, let's do 20x on this == 64M.

 

158M + 64M == 222M. Still lower than market cap.

 

Your turn to provide your data now.

[Guest notorious546]

Jurgis i reviewed your numbers they look good.

 

For reference, the CAD asset managers traded at about 13x earnings and a price to book value multiple of about 4.0x.

 

higher than 4.0x book value might not be to unreasonable on the royalty assets you have outlined. Just my two cents though.

 

yesterday someone sold a market order on some shares pushing them down to about 5.00. Let's hope there is more of that

 

 

[Haasje]

I'm looking a bit more closely at FRMO once again. I have some trouble with the Bermuda Stock Exchange valuation. Did any of you get anywhere trying to value that piece and how did you do it? It's kinda tough  :-[

 

 

[KinAlberta]

Jurgis i reviewed your numbers they look good.

 

For reference, the CAD asset managers traded at about 13x earnings and a price to book value multiple of about 4.0x.

 

higher than 4.0x book value might not be to unreasonable on the royalty assets you have outlined. Just my two cents though.

 

yesterday someone sold a market order on some shares pushing them down to about 5.00. Let's hope there is more of that

 

A bit more dissatisfaction with the stock, the price, or the direction of both, seems to have arisen again today.

[Jurgis]

Looking at http://www.horizonkinetics.com/articles.asp?pageID=5 , I am not very happy about the continuous index/ETF dissing. OK, I understand these guys are not happy about indexes/ETFs, index/ETF performance and overvaluation. Personally, I think their time would be better spent on figuring out what to do in current environment instead of writing missives to the misguided (?maybe?) index/ETF/dividend investors. Maybe they feel this is their civic duty, but IMO it's not and IMO it's not very productive.

 

BTW, I don't think this applies to just FRMO. I think the same about Pabrai's recent talk and I think Watsa had some complains about overvaluation of FANG/unicorns too. At least Watsa spends way more time on Fairfax's businesses and investments.

 

We'll see how things look when FRMO reports annual results.

[Fowci]

Looking at http://www.horizonkinetics.com/articles.asp?pageID=5 , I am not very happy about the continuous index/ETF dissing. OK, I understand these guys are not happy about indexes/ETFs, index/ETF performance and overvaluation. Personally, I think their time would be better spent on figuring out what to do in current environment instead of writing missives to the misguided (?maybe?) index/ETF/dividend investors. Maybe they feel this is their civic duty, but IMO it's not and IMO it's not very productive.

 

BTW, I don't think this applies to just FRMO. I think the same about Pabrai's recent talk and I think Watsa had some complains about overvaluation of FANG/unicorns too. At least Watsa spends way more time on Fairfax's businesses and investments.

 

We'll see how things look when FRMO reports annual results.

 

Agree with you Jurgis - it comes off a bit obsessed...

[gg]

Looking at http://www.horizonkinetics.com/articles.asp?pageID=5 , I am not very happy about the continuous index/ETF dissing. OK, I understand these guys are not happy about indexes/ETFs, index/ETF performance and overvaluation. Personally, I think their time would be better spent on figuring out what to do in current environment instead of writing missives to the misguided (?maybe?) index/ETF/dividend investors. Maybe they feel this is their civic duty, but IMO it's not and IMO it's not very productive.

 

BTW, I don't think this applies to just FRMO. I think the same about Pabrai's recent talk and I think Watsa had some complains about overvaluation of FANG/unicorns too. At least Watsa spends way more time on Fairfax's businesses and investments.

 

We'll see how things look when FRMO reports annual results.

 

Agree with you Jurgis - it comes off a bit obsessed...

 

They aren't simply lamenting general over-valuation and complaining that they can't find underpriced securities. They are explaining the mechanics ofmoney flow in the ETF world, and how it impacts everything from spin offs, to volatility, to owner-operators and that these are the places that they feel have a decent shot at of finding undervalued securities.

[KinAlberta]

Looking at http://www.horizonkinetics.com/articles.asp?pageID=5 , I am not very happy about the continuous index/ETF dissing. OK, I understand these guys are not happy about indexes/ETFs, index/ETF performance and overvaluation. Personally, I think their time would be better spent on figuring out what to do in current environment instead of writing missives to the misguided (?maybe?) index/ETF/dividend investors. Maybe they feel this is their civic duty, but IMO it's not and IMO it's not very productive.

 

BTW, I don't think this applies to just FRMO. I think the same about Pabrai's recent talk and I think Watsa had some complains about overvaluation of FANG/unicorns too. At least Watsa spends way more time on Fairfax's businesses and investments.

 

We'll see how things look when FRMO reports annual results.

 

Agree with you Jurgis - it comes off a bit obsessed...

 

They aren't simply lamenting general over-valuation and complaining that they can't find underpriced securities. They are explaining the mechanics ofmoney flow in the ETF world, and how it impacts everything from spin offs, to volatility, to owner-operators and that these are the places that they feel have a decent shot at of finding undervalued securities.

 

The Exxon example was very interesting.

 

I always figured indexes could buoy up share prices a bit and de-indexing created an automatic sell off that one could profit from when the shares recovered post fund and ETF exiting.  (I don't short.)

 

However, the growing volume of ETFs and indexes is creating new issues (while growth continues). Seems that with the weight of indexing going on (per the Exxon example) a weak company that first gets buoyed up or ‘protected' from their direct economic/business reality that then eventually gets de-indexed, could experience a massive price decline (the hedge is off).

 

Oil is interesting and maybe unique because falling oil prices likely led to increased equity index/ETF investing and so created an automatic hedge on Exxon’s price.

 

I'd also guess that 'the shorts' are probably spending more and more time looking at fringe indexed companies than ever before.  Longs should maybe wait a bit longer than in the past before picking up recently de-indexed companies hoping for a shooting through of the intrinsic value to an even greater downside extent. (The automatic stabilizer effect of indexation comes off and to great investors surprise their awakening to reality could exacerbate the downside movement.)